key term - Short-Run Average Cost

Definition

Short-run average cost (SRAC) refers to the average cost of producing a certain level of output in the short-run, where at least one factor of production is fixed. It represents the total cost of production divided by the quantity of output produced, considering the constraints of the short-run time frame.

5 Must Know Facts For Your Next Test

1. The short-run average cost curve is typically U-shaped, reflecting the law of diminishing returns as output increases.
2. The minimum point of the short-run average cost curve represents the most efficient level of production in the short-run.
3. As output increases, the short-run average cost curve will first decrease due to economies of scale, then increase due to diseconomies of scale.
4. Fixed costs in the short-run do not change with output, while variable costs do, affecting the overall short-run average cost.
5. The relationship between short-run average cost and marginal cost is crucial, as marginal cost determines the slope of the short-run average cost curve.

Review Questions

• Explain how the law of diminishing returns affects the shape of the short-run average cost curve.
  • The law of diminishing returns states that as more of a variable input (such as labor) is added to a fixed input (such as capital), the marginal product of the variable input will eventually decrease. This leads to the short-run average cost curve being U-shaped, as the average cost initially decreases due to economies of scale, then increases due to diminishing returns and diseconomies of scale as output continues to rise.
• Describe the relationship between short-run average cost and marginal cost, and how this relationship determines the shape of the short-run average cost curve.
  • The relationship between short-run average cost (SRAC) and marginal cost (MC) is crucial in determining the shape of the SRAC curve. When MC is below SRAC, the SRAC curve will be decreasing, as the addition of each new unit of output is lowering the average cost. However, when MC rises above SRAC, the SRAC curve will begin to increase, as the marginal cost of producing additional units is now greater than the average cost, pulling the average cost upward. This interplay between SRAC and MC results in the characteristic U-shape of the short-run average cost curve.
• Analyze how changes in fixed and variable costs in the short-run affect the short-run average cost curve.
  • In the short-run, where at least one factor of production is fixed, changes in fixed costs will shift the entire short-run average cost (SRAC) curve up or down, as fixed costs are spread over the quantity of output. However, changes in variable costs will affect the slope of the SRAC curve, as variable costs directly influence the marginal cost of production. An increase in variable costs will cause the SRAC curve to become steeper, while a decrease in variable costs will make the curve flatter. These changes in the fixed and variable cost components directly impact the shape and position of the SRAC curve in the short-run.

Related terms

Short Run:

The period of time in which at least one factor of production is fixed, while others can be varied to adjust output levels.

Average Cost: The total cost of production divided by the quantity of output produced, representing the average cost per unit of output.

Marginal Cost:

The additional cost incurred to produce one more unit of output, which is a key determinant of the shape of the short-run average cost curve.